Beware banks offering debt protection
Worried about debt in the event of death or unemployment? There are much better alternatives to the debt-protection products sold by banks and other lenders.
This post comes from Brandon Ballenger at partner site Money Talks News.
These days, you can buy insurance for almost every area of life. In addition to your life, home, car and health, you can buy policies to protect pets, weddings, cellphones -- even debts.
Debt protection comes in various forms. Some plans pay off your balance if you die, others cover minimum payments if you lose your job or become disabled. The policies are pushed by providers of all kinds of debt, from credit cards to mortgages.
While protecting yourself from a loss of income seems sensible, when it comes to debt protection, the devil is in the details.
How debt protection works
There are different kinds of debt protection. Some will extinguish part or all of a debt if you die during the coverage term. Others guard against unemployment, promising to cover a certain number of minimum monthly payments if you're laid off. There are plans that will make your payments if you become disabled. There are even plans that pay three minimum monthly payments if you get married or divorced, adopt a child or buy a home.
In the video below, Stacy Johnson takes a closer look at these plans. Check it out, then read on for more.
But let's take a closer look. For instance, benefit caps usually apply, and the maximum the protection will pay could be as little as $500. For unemployment protection, qualifications may include being a permanent employee working more than 30 hours a week for at least three months, then qualifying for state benefits after two months without work. And for either disability or unemployment, you may have to provide regular proof you can't (find) work.
Don't even think about debt protection without understanding the fine print. Ask about limitations, waiting periods, how to cancel and whether you can get any refund for doing so.
Cost vs. benefit
As with anything you buy, it's important to consider what you pay for what you get. As Stacy mentioned in the video, a Government Accountability Office study from 2011 (.pdf file) revealed that creditors took in about $2.4 billion for debt protection that year on 24 million accounts, but paid only about 21% of that back in benefits. That's super-profitable for them, which makes it questionable for you.
Prices typically range from 85 cents to $1.35 per $100 owed, so on a $5,000 credit card balance you'll pay up to $67.50 a month, or $810 a year. In addition, since the cost is added to the balance, you pay interest on it too.
Pushing too hard
In July, the Consumer Financial Protection Bureau fined Capital One $210 million over allegations that it deceptively sold services like identity theft and debt protection. Two-thirds of that was refunded to 2 million customers.
Also in July, HSBC set aside $1.3 billion for British customers pushed into buying protection. And in June, Hawaii sued banks, including HSBC, Bank of America and JPMorgan Chase, for allegedly improperly pushing debt protection and other "add-on" credit products.
Now some big banks are getting out of the protection business. Reuters recently reported that Bank of America and Capital One have stopped offering payment protection. (The former will continue providing it for free for the next six months to customers who have already signed up for it, and the final settlement of a class-action lawsuit may mean $50 to $100 refunds for affected customers.)
Chase still offers it to existing customers but says it stopped peddling protection to new ones last October. Citigroup has stopped telephone sales of the products for now but still offers them online and by mail.
Alternatives to debt protection
Debt protection makes the most sense when you expect to be unable to pay your bills soon and have no other options. Otherwise, a few alternatives may have more appeal.
- Build an emergency fund. If you have a $5,000 credit card balance, rather than paying $67 a month for protection, put that money in a savings account instead and create a cushion to soften the blow of cash flow problems.
- Pay down debt. Instead of prolonging the problem by spending money on debt defense, work on your offense. Paying more toward your debt each month will mean getting out of debt faster and spending less overall, and may improve your credit score by lowering your credit utilization ratio.
- Consider a life insurance or disability policy. Another option is broader coverage that may offer more protection at a better price. Disability or life insurance, for example, will provide cash that can be used for expenses other than debt. But be sure to study the details and comparison-shop.
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